BUSINESS

They won’t butt out

A Canadian tobacco firm threatens a landmark $206-billion deal

JASON KIRBY October 30 2006
BUSINESS

They won’t butt out

A Canadian tobacco firm threatens a landmark $206-billion deal

JASON KIRBY October 30 2006

They won’t butt out

BUSINESS

A Canadian tobacco firm threatens a landmark $206-billion deal

JASON KIRBY

It’s a long way from the little brown courthouse in Cayuga, Ont., to the august halls of the Supreme Court in Washington, D.C., but Ken Hill’s legal battles run the gamut. Back in June, at the height of the standoff between natives and residents of nearby Caledonia, police charged Hill, a former band councillor, with two counts of assault after a fight near a makeshift barricade. Hill’s lawyers made a brief appearance at the provincial courthouse in Cayuga last week. Few people cared, or even took notice—unlike south of the border, where Hill’s judicial wrangles are a good deal more momentous, and have caught the eye of everyone from bond investors to Big Tobacco. On Oct. 10, the U.S. Supreme Court paved the way for a tobacco manufacturer Hill coowns, Grand River Enterprises, to sue 31 states and challenge a landmark tobacco settlement reached in the late 1990s. Should

Grand River emerge victorious, experts warn, investors and U.S. taxpayers could take a multi-billion-dollar hit. “If they win this,” said Richard Larkin, a senior vice-president of JB Hanauer, an investment firm in New Jersey, “it could be very damaging.”

When U.S. tobacco companies agreed in 1998 to fork out US$206 billion over a 25year period to settle health-related lawsuits, it was widely seen as a victory for government lawyers. Yet the four largest companies, Philip Morris, R.J. Reynolds, Brown & Williamson and Lorillard, were shrewd negotiators. If Big Tobacco lost any market share to companies not covered by the agreement, their future payments could be reduced. To keep Big Tobacco happy, each state imposed stiff financial penalties on any companies that didn’t sign on to the so-called Master Settlement Agreement—whether they’d ever been sued or not. Most small tobacco manufacturers caved in and signed the MSA. A handful, including Grand River, did not. Instead, they chose to fight the agreement on constitutional and anti-trust grounds. The deal, they argue, amounts to a state-sanctioned cartel.

Eight years on and fewer people are sparking up Marlboros, while Grand River has seen its U.S. sales grow 50-fold, according to court documents. Without missing a beat, RJR and Lorillard tentatively withheld US$755 million from this year’s settlement payment. The problem is, many states already spent their share of that money. Rather than wait for the settlement cash to slowly roll in, they packaged the payments as bonds and sold them to investors, immediately raising US$35 billion. Not only do those bonds now pose a risk to investors who bought them, some states like California guaranteed the bond payments with public funds.

If Grand River succeeds in blocking state laws that require it to pay into special escrow accounts, where the money would sit in case the company is ever sued, Big Tobacco could scale back their payments in a big way. “Grand River would be free to sell their cigarettes and not post escrow, which would un-level the playing field,” says a source close to the state attorneys general named in Grand River’s suit. “A state could lose up to 65 per cent of its payments if it didn’t have the escrow statutes in place.”

Exactly how a small native-run tobacco manufacturer from Ontario came to play such a pivotal role in a U.S. anti-trust suit dates back to the early 1990s, when a group of businessmen from the Six Nations of the Grand River Territory, south of Brantford, Ont., launched the company. Hill owns 10 per cent. The group today has its fingers in

a host of ventures, ranging from online gambling to bottled water. But it’s their cancer stick business that brings in the big bucks. Grand River may not be a household name like Rothmans and Benson & Hedges, yet the 14-yearold company still cranks out roughly five billion cigarettes a year from its plant on the reserve, enough to make it Canada’s fourthlargest cigarette manufacturer. And it’s got a thriving export business. Earlier this year, Grand River reportedly signed a $50-million deal to supply cigarettes to the German armed forces, while convincing officials there to subsidize a new plant in the city of Brandenburg to the tune of nearly $20 million.

Grand River has also made its seven or eight shareholders millionaires many times over. Between 2003 and 2005, Grand River paid them $64-9 million in management bonuses, according to court filings. They declined to be interviewed for this story.

Grand River, along with other small American tobacco companies like Freedom Holdings and 3B Holdings, filed their anti-trust lawsuits around 2002. It has also sued the U.S. government under the North American Free Trade Agreement.

While naming dozens of state attorneys general in its suit, Grand River sought to have the case heard in New York alone.

It was a brazen move. One state’s courts generally don’t have jurisdiction over another’s. But in 2004, a 2nd circuit court said since the tobacco agreement had been hammered out in New York, the lawsuit could go ahead there. The states appealed to the U.S. Supreme Court, which this month declined to hear the case.

A victory for Grand River is far from certain, though. Earlier this year, the company asked a court in New York to block states from forcing it to pay into the escrow accounts until a final decision is reached. So far, according to Leonard Violi, Grand River’s lawyer in New York, the company has paid US$7 million. But the judge seriously questioned whether the company would eventually succeed in its legal battle, and turned down the request.

Even Violi admits the courts could be loath to overturn any part of the massive tobacco

ANALYSTS HAVE THRASHED TOBACCO BONDS OVER FEARS REVENUE MIGHT NOT MATERIALIZE

settlement. He said Grand River has also asked the courts to let it into the agreement on more favourable terms. “There’s no question the agreement is uncompetitive,” he says. “But when you talk about a product called tobacco, which is deemed a pariah for some reason, and secondly you’re talking about states getting so much money into their coffers, it causes the courts to be hesitant.”

Still, investors like Larkin at JB Hanauer, which sold tobacco bonds to its clients, are watching the case closely. Analysts have already thrashed the bonds over fears the tobacco revenue might not materialize. “I’m not a legal expert but I think they’ve got a pretty good case because they’re being asked to pay something that is uncompetitive,” he says. “Tobacco bonds could be in a great deal of risk.” M